What HP can tell us about the tech industry downturn

With the exception of its services group, whose numbers were inflated by the …

I've read a lot of downturn-related news in the past few months, but I have yet to see anyone make the connection between job losses and printer ink usage. That changed yesterday, though, with HP CEO Mark Hurd's comments on HP's most recent quarterly earnings call: "There is definitely an alignment between—or at least some alignment between GDP and unemployment and printing. So when you get down to the end of the day, when you don't have a job, you are not printing as much is typically how it works. And we have some pretty sophisticated models."

All of that not working and not printing added up to a pretty ugly quarter for HP, but the company's first quarter results speak to much more important themes than just a dearth of demand for ink. Looking at HP's quarterly earnings is like looking at a snapshot of the downturn's impact on the entire tech industry, and a close reading of it reveals how the ground is shifting beneath everyone's feet.

HP by the numbers

Before we talk big-picture, let's take a quick look at HP's first quarter results.

In the first quarter of the fiscal year, revenue from HP's Imaging and Printing Group was down 19 percent year-over-year, as was the revenue of the Personal Systems Group (i.e. PCs and portables); the Enterprise Servers and Storage group was down 18 percent. HP Software fared considerably better with only a 7 percent decline, while HP Financial Services saw only a 1 percent dip.

But the star of HP's balance sheet this quarter was the company's Services Group, which, thanks to all of the business that the company bought when it acquired EDS for $13.9 billion back in May, saw a 116 percent year-over-year increase. Indeed, HP's successful acquisition and integration of EDS was the only thing that saved the company's numbers from the same double-digit sea of red-ink as every other computer company.

All told, these numbers add up to a 1 percent year-over-year increase in net revenue, and a 13 percent quarter-over-quarter decline that underperformed analysts' expectations and sent HP's share price tumbling to its lowest point since the summer of 2006.

Surveying the damage

Because HP has its fingers in so many pies it can serve as a microcosm of the tech industry as a whole.

Looking at the company's PC business, we see the same story we've been tracking for months now continue itself in HP's first quarter numbers: desktop PC unit shipments dropped by 15 percent, while notebook shipments jumped by 8 percent thanks to netbooks. This shift in HP's product mix from high-margin desktop PCs to low-margin portables shrunk their PC business's overall margins.

HP's enterprise hardware told a similar story of double-digit declines, but in this market the part of the netbook was played by Intel's Xeon. Xeon-based ESS blade revenues were actually up 4 percent, while revenues across the rest of the enterprise business (including Itanium) were down. Again, the shift was to lower-margin, commodity x86 products from higher-margin alternatives. I'll return to this point in a moment, but before I do I should mention the geographic breakdown.

In a nutshell, the Asian and emerging markets were a bloodbath. I'm going to reproduce HP's "Regional revenue trends" slide from the presentation yesterday, because it's worth staring at:

This slide illustrates as clearly as anything where the pain is right now for tech companies in the global economy. The numbers out of Japan are frightening, and the entire Asia-Pacific region is in free-fall by any metric that matters. Any tech companies with exposure here, which is essentially all of them (these were hot growth markets until relatively recently) will feel the crunch.

Downturn is good for x86, bad for Intel

Circling back to HP's enterprise numbers, it's clear that Xeon remains the biggest threat to Itanium out there. Even in its aging "Penryn" incarnation, Xeon lets cost-sensitive customers sacrifice a bit of performance to save money, and HP's customers are clearly turning to it for those reasons. And when the new Core i7 Xeons launch this year, they'll have the bandwidth and horsepower to compete even more capably with Itanium, especially on price/performance.

Along these lines, Brook Crothers over at CNET scored a great interview with Unisys's head of Systems and Storage, in which the exec revealed that his company is dropping Itanium for Xeon because the RAS part of Itanium's value proposition just isn't there. "We track the unplanned downtime of our customer base and we track pretty much identical results between Xeon and Itanium architectures with respect to downtime. We don't see any material difference whatsoever and we keep very detailed tracking on that," he told Crothers. So HP is pretty much what's left of the Itanium market, and again, Xeon is making inroads even there.

This industry-wide move to lower-cost hardware, where "cheap" is the new "fast," has been well documented here at Ars, and it's fascinating to see that it's affecting HP in both the PC segment (with the move to netbooks) and the enterprise segment (with the move to Xeon).

Of course, both HP and Intel would like customers to return to buying their higher-margin products ASAP, because the shift to lower-margin offerings in every segment is ultimately responsible for the brutal revenue drops we're seeing.

The multibillion dollar question is, when demand ultimately recovers, what sort of demand will it be: demand for a higher volume of cheap stuff, or demand for a smaller volume of expensive stuff? If the answer is the former, and the changes that we're seeing in product mixes across all segments are more or less permanent, then the semi industry will have to be structured very differently than it has been for the past 25 years. And that would mean big changes (or worse) for incumbents like HP and Intel.

Cutting costs

However things ultimately turn out, HP's plans for the meantime are to cut costs, hunker down, and wait for some sort of demand to return to the market. CEO Mark Hurd remarked that HP's customers are opting to limp along with aging machines, rather than keep up their normal refresh cycles. Customers are also holding off on launching new projects, and in general, everyone is out to conserve cash.

Part of HP's cost-cutting measures involves pay cuts, which Hurd announced today in a staff e-mail. Hurd himself is taking a 20 percent pay cut, with pay cuts for other execs reduced by 10 and 15 percent. Lower-level employees will face cuts in the 2.5 to 5 percent range. By cutting pay this way, the company is trying to avoid handing out another round of pink slips.